Baupost Group’s Seth Klarman Sees ’50 Shades of Value’ in The Market

According to the latest update from Baupost Group’s, the hedge fund’s performance last year was fairly strong. Seth Klarman, founder of the hedge fund, in his 2012 year end letter, commented on how the market has changed dramatically over the last few years. He jokingly regrets titling his value investing guide “Margin of Safety,” which was written 20 years ago. he should have called it Fifty Shades of Value.

“[It] would have sold far more copies had I used the alternative title,” he wrote in his 2012 shareholder letter.

The book may be slightly outdated but it difficult for analysts to argue with the company’s results over the last 30 years; Baupost Group has so far accumulated $17.6 billion in profits since its inception in 1983.

Klarman explained that he follows the investment philosophy of Graham and Dodd and prides himself on maintaining a handsome cash balance (33 percent on average). He is also unfazed by all the media attention that has been focused on him and his firm; however, he said he still prefers that his team’s investment ideas are not discussed publicly. This is in line with thoughts of Warren Buffett who has also said that media scrutiny of investments can do more wrong than good.

In his year-end letter, Klarman criticizes the hyperactivity of the governments these days and said that this new approach to moving markets and shotgun investing was not covered in his book.

Klarman’s displeasure with the way the Fed and ECB has handled the whole crisis is grossly evident in his tone. The even bigger danger sign than the quantitative easing itself is the ease with which investors react to it and take it as a commonplace event.

He comments that as the indirect result of the fiscal easing policies, U.S. public debt has multiplied in the last four years from $10.6 trillion to $16.4 trillion which amounts to an increase of $50,000 per household. The Congressional Budget Office estimates public debt to equal 90 percent of GDP in the next decade.

Moreover the budget defect keeps mounting up without any foreseeable means of funding except for taking more money. Klarman comments that the mindset of the current leadership is blindly ignorant while the business community has also shied away from worrying about the time when Fed ceases easing, increases interest rates and governments start selling the trillions they have accumulated in securities and bonds.

On a brighter note, Klarman is optimistic about the U.S. oil and gas sector, which has achieved some form of independence and can assist the growth of other industries and manufacturing pipeline of the country. He also notes that despite of the volatility in U.S. markets, the global market has been stable; the VIX Volatility Index posted a five year low. He sees this lack of market swings, referred to as the ‘Bernanke Put’, as a challenge in Baupost’s style of investing which benefits from changing prices.

In support of volatile markets, Klarman mentions Nassim Taleb’s book “Antifragile” which appreciates the fruits of volatility. Klarman argues that the Antifragile approach means that the market can be unpredictable but stil follows a business cycles, which are artificially masked when over-zealous governments get into action. .

In an attempt to anchor the institutions that failed in 2007-08 crisis, it seems the U.S. administration is trying to cycle back to the same conditions that lead to the financial collapse in the first place. At the same time there are several indicators that have fallen even lower than 2007-08 levels like, government credibility, labor participation and median household income.

The letter recounts the many big incidents that have moved markets in the last few years. Klarman recounts the debt collapse of companies like Texaco, Lehman Brothers, Macy’s, Inc. (NYSE:M), Washington Mutual, WorldCom and others and the recent crisis in Greece, one that Baupost Group profited from. We also recently reported the potential of big gains from a Bernard Madoff’s Ponzi scheme.

Jim Mooney, Head of Baupost’s Public Investment Group, comments that while the Lehman opportunity may soon close (an investment that has returned big gains for the firm), the fund is focused on looking for opportunities in European peripheral countries.

As mentioned in an earlier post, Baupost profited in its holdings in Greek sovereign debt. Baupost’s Private Investment Group has not found any attractive openings in Europe’s non-performing loan market as yet, but is on the lookout.

Currently the firm is wearing a risk-off approach and Klarman reiterates that the Baupost is sticking to the traditional ways of investing. The managers will not indulge in following the herd but will focus on protecting the capital of investors.